The Cause Of The Eurozone Crisis Was The Euro: The Solution Is Abolition Of The Euro

There's a fascinating little book out from one of the think tanks in the UK talking about what went wrong with the Eurozone crisis. There's much in it that's both useful and accurate. But I'm afraid that they completely miss the major point of the subject under discussion. They talk to us about institutional problems, about how various parts of the crisis were mismanaged and so on. But they entirely fail to grasp the most basic point about optimal currency areas. Which is that the Eurozone isn't one, is most unlikely to be one for a century or so and that therefore there always was going to be a crisis if the Eurozone was created. It was and there was and the reason there was was because of that very creation. Different political structures would not have stopped it, different actions by the major players during it would not have stopped it either. Essentially, they manage to identify certain proximate causes but fail entirely to note the ultimate cause: the existence of the euro itself.

As a first step to finding a broad consensus on what more needs to be done, we gathered essays from 20 world-renown economists on a simple question:

“What caused the Eurozone Crisis?” The eBook which we launch today: The EZ crisis: A consensus view of the causes and a few possible solutions, presents their views. This eBook focuses on causes since ‘if you don’t know what is broken, you don’t know what to fix.’

Although the essays were largely uncoordinated – and the authors have diverse backgrounds – a remarkably coherent message emerges from this collection of essays.

Excessive, cross-border foreign lending and borrowing among EZ members in the pre-crisis years – much of which ended up in non-trade sectors – was why Greece’s 2009 deficit deceit could trigger such a massive crisis. At its core, this as a classic ‘sudden stop’ crisis – not a public debt crisis.

The 1990s was a time of exchange rate turbulence in Europe with major crises in 1992 and 1993. In the face of large differences in inflation rates and the occasional devaluations, markets demanded very large risk premiums. Nations like Italy, Spain and Portugal paid far higher rates on their debt than Germany and other DM-bloc countries (Netherlands, Austria, France, and Belgium). That all changed with the move towards monetary union.

That's really quite remarkable in its blindness. Because the previous exchange rate turbulence came from the previous attempt to fix currency values across the European Union. Everyone was to have their currency trading in a band in relation to each other (effectively centered upon the DMark) and the problems arose because the different economies of Europe were, umm, well, they were different. So holding those exchange rates became impossible. This is, recall, the time when George Soros made a $1 billion out of the Bank of England in one day. It rather beggars belief that the powers that be observed all of this and said "You know what, fixed exchange rates in Europe don't work. So let's have just the one currency and fix exchange rates for all time!". But that is what they did and that is the basic problem.

Even a cursory glance at the economics of this field, optimal currency areas (founded by Robert Mundell) tells us that over such disparate economies a single currency just isn't going to work. Yes, it's possible to expand an optimal area by having a common fiscal policy to go along with a common monetary one. But Germany and Greece, Germany and Ireland, this is just too large an area: even common fiscal policy would not lead to an optimal area. Even if that common fiscal policy were of the size of that in the US (where some 20% of GDP cycles through Washington, and believe me, no one at all is going to accept 20% of Eurozone GDP cycling through Brussels) it still wouldn't come close to being anything like an optimal area.

And that was the original mistake: in constructing the common currency at all. When they do discuss what went wrong they're OK on the proximate causes:

Causes of the crisis The proximate cause of the EZ crisis was the rapid unwinding intra-EZ lending/ borrowing imbalances that built up in the 2000s. Some of this was to private borrowers (especially in Ireland and Spain) and some of it to public borrowers (especially in Greece and Portugal), but in every case the difficult debt mostly ended up in government hands. As Thorsten Beck and José-Luis Peydró put it: “Often this private over-indebtedness ends up on governments’ balance sheets, so that the rise in public debt is more a consequence than a cause of a financial crisis.” This ‘sudden stop’ was a crisis rather than a problem since EZ members could not devalue and their central banks could not bail out the government. As Paul de Grauwe writes: “Countries that have their own currency and that are faced with such imbalances can devalue or revalue their currencies.” This was not an option for the GIIPS.

Yes, fair enough. But as to the ultimate cause, they whiff it:

Causes of the causes The causes of the crisis – imbalances and lack of crisis management mechanisms –tell us that there are really three sorts of underlying causes: • Policies failures that allowed the imbalances to get so large; • Lack of institutions to absorb shocks at the EZ level; and • Crisis mismanagement.

Nope, the ultimate cause was the idiot decision to have the euro in the first place, made worse by extending it beyond where it could possibly have worked with some pain even without being optimal (roughly, Benelux and Germany only) to everyone who could manage to lie their way into political acceptance. And until people start to realise that that was the original mistake and the ultimate cause of the eurozone crisis then no one is going to be stating what is the obvious solution.